Vaishnavi Sharma | July 21, 2015
Greece accounts for just two per cent of the GDP of the Euro zone. But the turmoil in that country has had effects on some of the major economies of the world. This necessitates an attempt to understand the causes and implications of the Greek debt crisis.
Greece became the twelfth country to join the euro zone just before the launch of the euro in the beginning of 2002. For becoming a part of the Eurozone, the countries needed to demonstrate “economic convergence” with other members in order to ensure that the common currency would not get jeopardized.
However, like few other countries, Greece too lacked certain requirements then. The budget deficit was supposed to be less than 3 per cent of GDP. While Greece manipulated its books to show wrong figures till early 2004 (1.5 per cent), the new government that came to power then, realized that the actual figures were actually 8.3 per cent. But since Olympic Games were returning to Greece, considered the land of games birth, the actual figures of the debt were not revealed.
So, instead of dealing with this crisis, the Greek government suppressed it and did nothing. In the aftermath of the global financial crisis in 2008, Greece was one of the European countries (others were Ireland and Spain) which suffered the most. With a large gap between revenue and expenditure, the problems of Greek economy became too big to be hidden anymore. The debt component kept rising. Greece was in dire need of financial help.
The Eurozone countries feared that Greece’s payment crisis would lead to increase in their cost of borrowing and they succumbed to helping Greece. In 2009, after the Greek government announcement about false deficit figures, further doubts were raised about the soundness of its finances and ability to pay off debts. Greece's credit ratings were downgraded, first by Fitch and then by Moody's. Greece’s debt to GDP ratio jumped to 146 per cent in 2010 after which the country was downgraded to junk bond status.
In May 2010, to stop the crisis from growing, the International Monetary Fund (IMF), the European Central Bank (ECB) and European Commission (EC) arranged funds of 110 billion euro to bail out the country. The bailout came with strict conditions about improvements in tax collection, privatization, saving government money (by laying off workers), improve efficiency and propel growth. But this led to rise in unemployment, less disposable income hurting other businesses, further depressing tax revenues leading to deepening of the crisis. Another bailout plan of 130 billion euro was worked out in February 2012 along with a new and stricter austerity programme. The international debt to these lenders rose to 135 per cent of GDP.
These bailout packages were mostly utilized for paying earlier debts and hence did little in balancing the budget. The situation, instead of improving, worsened further with unemployment rising to 25 per cent and youth unemployment soaring to a whopping 50 per cent.
The austerity measures attached with the loans were highly detested in Greece. This led to snap elections in December 2014 whose central issue was the austerity measures.The Syrizan party won the elections on the grounds of anti-austerity. The new government led by Alex Tsipras declined to accept the terms of the agreement. This uncertainty resulted in the suspension of the remaining tranche of aid.
In June this year, Greece missed the deadline for a 1.5 billion euro repayment to the IMF, the first European Union country to do so ever. The banks started to run out of money. Capital controls were introduced, limiting the amount of money people could withdraw each day to 60 euros (earlier the banks had closed for two weeks). The Greek government held a referendum on July 5 in which the Greeks voted against austerity measures, necessary for further loans.
With much negotiations and few options left, the Greek government agreed to a third bailout deal of 86 billion euros in exchange for tougher reforms. So, for the time being, Greece is very much a part of the Eurozone. But the real questions that arise now are: Are these bailout plans sustainable for Greece? Will they help Greece revive its economy or like the earlier bailout packages even this one would go in repaying the earlier debts? How are the issues of unemployment and public unrest going to be addressed in the near future? Will Greece be able to adjust in the Eurozone or is it just a temporary phase and it will be on the brink of collapse and default once again?
Let’s take up some basic points before reverting to these concerns.
At first, the reasons behind Greece getting into this debt crisis
Just like an individual piles up his/her debts if he/she spends more than what he earns, Greece has accumulated its debt over time by spending more than it earned/earns. Constant borrowings by the government to finance its promises, has led Greece on this path of unsustainable development. There are various other structural issues which worsened the economy even more. For example, Greece has a retirement age of 57, even lower than that of the US. While retiring early is good for the Greek workers who start getting paid out benefits early, it’s a major financial burden for the government. Tax collection mechanism is also inefficient in the sense that tax evasion in Greece is legendary and tax payers dodge their tax obligations which further increases the burden of the already debt-strapped government.
Secondly, reasons behind the loans
Initially Greece took money from the European banks (those same banks agreed to a 50% haircut on those loans in October 2011) but it could not pay back. At the same time, it could not even raise money from the public markets as investors’ feared lending money to Greece on doubts of its repayment capabilities. With Greece at the brink of bankruptcy in early 2010 and the threat of financial contagion approaching, the troika came forward with two bailout plans of 240 billion euros. Today, bulk of the loan amount that Greece owes is to the troika led by the IMF and not the European banks.
Thirdly, the reasons behind Greece defaulting
This was simply because Greece does not have the money to pay back. The bailout money was used to pay earlier debts rather than utilizing for the revival of their economy. On the other hand, the austerity measures imposed on the Greek economy in exchange for the bailout packages were stringent. They implied certain structural reforms necessary to bring the economy back on track. But these measures worsened the economic condition of Greece. GDP fell by more than 30 per cent; unemployment rose to more than 25 per cent. And according to the latest World Bank data, Greece’s debt to GDP ratio is nearing 200 per cent. And at this point of time, with such enormous debt and underperforming economy, it is impossible for Greece to pay its debts even in future.
Fourthly, with the third bailout plan what one can expect of Greece
Greece has received its third bailout package of 86 billion euros of financing over three years. The bailout is conditional on reforms including measures to streamline pensions, raise the revenue and liberalize the labor market among others. The agreement included an offer to reschedule Greek repayments “if necessary” but did not include any provision for the reduction in Greek debt that the Greek government had sought.
The present government had come to power on a promise to end austerity. But with the acceptance of this bailout package, the present government has agreed to impose the strict austerity measures attached with the bailout. This has led to widespread anger and public unrest in Greece. In the near future, the Greek economy cannot be expected to grow at some remarkable rate; unemployment situation is also not likely to improve soon. Brain drain of the brightest and the best would continue.
Fifthly, our expectations of Europe
Today, the European banks don’t hold much loan against Greece, bulk of the loaned amount is against the troika. With the latest bailout package, Greece is not exiting the Eurozone, at least for the time being. However, even if Greece disagreed to the terms of the bailout package and decided to exit the Eurozone, European Union did not have to suffer much. With a corpus of over 500 billion euros, the ECB has erected a firewall and would do all it can to make sure any financial explosion is contained. In this case, Greece had to suffer even more, at least initially.
Sixthly, the probability of Greece defaulting in future
Yes, there are ample chances of Greece defaulting in future. This is so because with further austerity measures, there are bleak chances of recovery in the overall economic status of the country. These measures are more focused towards balancing the debt status (budget) of the country than increasing the national income and employment generation. There is another issue which hinders the growth of the Greek economy here: the common currency of the EU-euro. Whenever a country borrows too much, the IMF recommends that it write down its debts, balance its budget and devalue its currency. The point to note here is: when on the one hand, taxes are raised and expenditure is cut hurting the economy, on the other hand, measures should be taken to make it regrow again. For this, a cheaper currency- a monetary stimulus is required. While Greece has done its austerity part on one hand, it did not get a cheaper currency to sustain its economy on the other which hurt its economy even more. Neither did it get any debt relief. And this concern remains in the future too.
Finally, reverting to the concerns which were raised earlier, we find, as of now, that the impact of the recent bailout package on the Greek economy in terms of its recovery is not lucid. The nation’s banks on account of ECB’s funding would be operational for business but other businesses suffering due to cash crunch would have no relief. Similarly, the employment status or the national income status doesn’t seem to be getting positively affected with this bailout package. All this, coupled with the stricter austerity measures, would lead to further public unrest and outrage. If Greece had its own currency to begin with, it would have depreciated it in order to gain competitiveness. This would have reduced the real wages but not the nominal wages creating money illusion which would hurt the Greek people less. But in the absence of any cheaper currency to hold on and with a compulsory euro to function with, the Greek economy does not seem to be sustainable. It appears to be a plausible conclusion that in these circumstances Greece would need many more bailout packages in future.
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